Strengthen Cost Management Through Internal Audit

Cost Management Through Internal Audit:

Jeff Monk, CQP FCQI, Managing Director of auditing training and consultancy firm, Jemo International, shares his simple steps to help organisations curtail costs and improve business performance through audits.

Many senior executives view quality as an overhead cost, necessary but not profit making. This article is based on work that we, Jemo International – a global auditor training and consultancy firm – did with a company, which then reversed this view and saved £4.5m, which equated to 10 per cent of its annual revenue. This was achieved in 18 months by auditing for cost saving opportunities and getting everyone involved in the improvements. The business also freed up around 20 per cent of its resource capacity. We called this project ‘Gold in the Mine’ (borrowed from Dr Juran) and it provided a focus to what happened next.

The essentials

Before you start, you need top management on board. This may seem obvious but it’s amazing how few senior managers believe there are deficiencies in the way things are done, especially if they were responsible for installing them. You then need to convince your colleagues that they can find these inadequacies and can become part of the solution. This is generally easier because it is the people who live with the day-to-day problems who often have good ideas on how to fix them and save costs.

Map the processes

You will need to map your main processes. If you have them in a flow chart, this is a good start. Check that they accurately reflect the actual practices. Then add ‘swim lanes’ that you can use to measure the process activity costs. We recommend using MS Excel for this. It is usually available to everyone and does not have the multi-user costs of some of the dedicated process mapping software.

The executives should first map their strategic processes and how they interrelate. To do this, you need to nominate a leader for each main process stream, which is essential before mapping the next level down processes. If there are any clashes or overlaps of responsibilities at this level they should be resolved. People lower down will need clear leadership.

Measure the costs

Every process activity is allocated a cell in Excel. Working on the principle that each activity consumes a resource, eg, time, money, energy, you can then calculate the cost of the activity working as it should do and the cost if it fails. Failure costs should also include estimates of any consequential costs (eg, a product recall or legal dispute). The method we recommend is Activity Based Costing (ABC), which can be used to accurately track the cost savings that come from process improvements. You can get your Accounts team to run this and integrate it with their business accounting methods. The cost savings you will make will go straight to the bottom line of profit.

Process and cost improvements

We recommend running small workshops that teach the process operators how to understand their processes. Then get people from interfacing departments in the same process stream to examine the existing processes and look for potential improvements. A question often asked is “Why do we do it like this?” The answer is often “We’ve always done it like that!”

This mapping is fine at the local level but the process streams need to be examined holistically from end to end. This is where your internal auditors can contribute the most. They will need to be trained in where to look for potential improvements. Typically, they may find some processes that are making up for deficiencies in upstream processes and communication issues where processes interconnect. The operators and staff that are being interviewed should be encouraged to put forward suggestions for how to improve this.

Reward and recognition

Some managers are not good at saying ‘thank you’ for a job well done. With costs savings of 10 per cent of annual revenue being made, we recommend a fund is put aside for reward and recognition. Five per cent of the savings is adequate.

Case study: Gold in the Mine

The UK-based company that sells essential supplies to schools, universities and government departments had received a significant investment that they had to pay back in three years. They needed to reduce costs and contacted us for help.

With our assistance, a project team was created, targets were set, and teams were selected and trained to:

  • understand, audit and map the existing processes;
  • identify where improvements could be made;
  • understand process cost measurement;
  • implement the improvements and audit the process chain.

The company’s top management mapped their main processes and we used an adaptation of Philip Crosby’s Management Maturity Grid to identify the potential cost gains to be made. The flow charts were done by the senior management of their top level processes and then we got them to see where they considered the organisation was on Phil Crosby’s Management System Maturity Grid. The consensus from the top managers was that they were at the awakening stage, which meant their actual costs of non-quality were probably 15 per cent of sales revenue. Recorded costs were at three per cent.

The process maps were subject to extensive peer review and everyone in the company was given the opportunity to comment and offer improvement suggestions. The peer review of the process maps was done by the employees involved with the processes and overseen by us in JEMO. This was important because not everyone took part in the process mapping workshops and we wanted everyone to have the opportunity to comment and take ownership of the processes.

The finished maps were posted on information boards together with photos of the teams that created them. This developed a culture of ownership of the processes and a desire for ongoing process and cost improvement that people were proud to belong to.

Finance took control of measuring the costs using ABC and integrated this with the company’s cost accounting system.

In just 18 months, the project saved £4.2m on an annual turnover of $45m. They eliminated an evening shift that was compensating for pick and pack errors, outsourced their transport and sold their truck fleet. The company paid back the investors ahead of target and bought out the lease on their buildings. Everyone was given a pay rise and five per cent of the savings was put into an ongoing fund for special team performances. Rewards were in the form of gift vouchers.

By following the examples outlined in this article, auditors will be able to help more organisations curtail costs, while improving their service offerings and processes going forward.

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Attribute to original publisher/ publishing organization: Jeff Monk, CQP FCQI, Managing Director of auditing training and consultancy firm, Jemo International,